Risk Management systems are known and are commonly employed by financial institutions, natural resource-based corporations, trading organizations, government regulators or other users to make informed decisions to assess and/or manage the risk associated with the operations of the user. Such systems are well known to be computer implemented and executed by a processor.
One popular example of a known risk management system is the RiskWatch V3.1.2 system, sold by the assignee of the present invention. This system is very flexible and allows users to employ models of the instruments in the user's portfolio, which models are evaluated at appropriate time intervals, in view of a set of possible scenarios. Each scenario comprises a vector of values for risk factors employed in the models, at each time interval, and each scenario has associated with it a probability of the scenario occurring. The resulting risk values of the instruments, when the models are evaluated under each scenario at each time interval of interest, are then used to produce one or more risk metrics which are examined to assess the risk to the user of holding the portfolio of instruments under the evaluated scenarios. The instruments which can be modeled and assessed by the system are not particularly limited. The system merely requires that an adequate model can be defined for the instrument. Instruments can include, without limitation, various financial instruments such as equities, options, derivatives, etc. and can also include non-financial instruments such as reservoir capacities, insurance products, etc.
Known risk management systems do however suffer from some problems. One of the more common problems is that portfolios being evaluated by prior art risk systems are generally modeled as static objects and yet portfolios change, or evolve, with time. For example, a bond in a financial portfolio can have one or more coupons which produce income at a specified time and thus the bond instrument evolves over time to become a bond instrument and a cash amount. As another example, a portfolio under consideration can include one or more options (for financial instruments, foreign exchange, commodities, etc.) that will be executed when “in the money” to buy or sell the underlying commodity, thus changing the portfolio composition. In either of these cases, and in many others, the portfolio being analyzed by the risk system changes, perhaps significantly, as time passes.
To date, the risk management systems and methods of which the present inventors are aware have not dealt well with the issue of portfolio evolution. Commonly, such systems have at best permitted the user to define a limited evolution strategy, for example specifying that the cash from a bond coupon will be re-invested into a pre-selected instrument, such as a money market account paying interest at the prevailing overnight interest rate, and have analyzed the risk under that assumption. In these systems, portfolio evolution is dealt with on a predefined, fixed, basis and, for example, the cash received from the bond's coupon discussed above will always be modeled as having been invested in the money market account (or whatever other instrument has been pre-defined by the user) even under scenarios wherein this will provide a poor investment return.
In the real world, which the risk system is attempting to simulate, a user would re-invest this cash into an appropriate instrument, in accordance with market conditions at the relevant time. Under some market conditions, the cash could be invested in a 90 day US T-bill and in other conditions could be invested in the money market account, a bond, etc.
In another example, a user can have a portfolio of short term bonds with mixed maturities which he wishes to perform various risk analyses on. Over some period of time of interest, such as a three to five year period, a significant portion of the bonds in the portfolio can mature. Prior art risk systems did not provide mechanisms whereby the maturity amounts of the bonds could be reinvested into instruments which were appropriate at the date of their maturing. Instead, the users of such prior art systems were forced to pre-define the re-investment instrument in a fixed manner, selecting a similar bond for example, even though under some particular scenarios under consideration this would represent a poor investment that the user would not actually make. Thus, prior art risk management systems are less accurate and less realistic at assessing risk of an evolving portfolio than is desired.
Further, a user of a risk management system can have developed one or more potential trading strategies to evolve their portfolios appropriately under a variety of market conditions, such as strategies which specify which types of instruments to divest from and which types of instruments to invest in under various possible future scenarios. Prior art risk management systems do not allow such a user to evaluate how well these potentially competing strategies perform or their effect on the amount of risk resulting for the associated portfolios.
It is therefore desired to have a risk management system and method which permits a user to employ dynamic trading strategies using rules which effectively define how a portfolio of instruments will evolve over time and to permit the user to assess the performance of competing sets of trading strategies.